A portfolio approach to improving market and credit risk management
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Date
2011/12/15
Authors
Botha, Marius
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Publisher
University of the Free State
Abstract
Afrikaans: Die kredietkrisis wat besig is om te ontvou (in 2008 ‘n aanvang geneem), het omtrent elke segment van die internasionale finansiële stelsel beïnvloed. Krediet is ernstig ingekort soos wat banke worstel om verdere verliese, veroorsaak deur roekelose uitleenpraktyke wat die afgelope 20 jaar gekenmerk het, in toom te hou. Batepryse het getuimel soos wat angstige beleggers na veiliger toevlugsoorde vlug, en tradisionele beleggings en verskansingsfondse laat vaar. Regerings, in ’n poging om stagflasie te voorkom en suk- kelende ekonomieë aan die gang te kry, het rentekoerse tot historiese laagtepunte verminder, aanspo- ringspakkette geïnisieer en reddingspogings vir banke aangevoor, maar die pogings het (tot op hede) ’n minimale tot geen effek op markte gehad. Die knellende ekonomiese omgewing, gekenmerk deur laer bedryfsproduksie, huis- (en ander bate-) pryse wat daal en stygende werkloosheid, het besteding en investering ontmoedig en kapitaalopgaring bevorder. In die daaropvolgende krisis, is die regule- rende ekonomiese omgewing (gedomineer deur die Basel II Akkoord van die Basel Komitee vir Bank Toesighouding (BKBT)) as ontoereikend bewys. Moontlike oplossings het hulle nog nie voorgedoen nie en dit lyk waarskynlik dat die krisis vir die afsienbare toekoms sal voortduur In die lig van hierdie gebeure en die hedendaagse tekortkominge van die finansiële omgewing oor die algemeen is die behoefte om voortdurend bestaande tegnieke om finansiële risiko te meet en te bes- tuur, uit te brei, asook om nuwe tegnieke te vind. Hierdie proefskrif verken vier belangrike probleme wat deur moderne risikobestuur in portefeulje verband in die gesig gestaar word. Die eerste probleem ondersoek die aanname van ’n normaalverspreide portefeulje-opbrengs. Onomstootlike bewys vir die deurlopende mislukking van hierdie aanname word gelewer. ’n Maatstaf wat portefeulje-prestasie in rangorde plaas, word bespreek en verduidelik met verwysing na verskeie Suid-Afrikaanse verskansingsfondsportefeuljes. Die tweede van hierdie probleme verken die aanname van onbeperkte likwiditeit in markrisiko metingsmodelle. Hierdie aanname word as misleidend bewys en daar word inderdaad geglo dat dit die hoofkomponent van die kredietkrisis is. ’n Nuwe portefeulje markrisiko model, wat die effek van we- senlik verminderde likwiditeit inkorporeer, word bekendgestel en op verskeie Suid-Afrikaanse porte- feuljes toegepas. Die resultate dui op ’n substansieel verbeterde model van markrisiko. Die derde probleem peil die effek van skuldenaar wanbetalingskwaliteit diskriminasie om ’n subtiele teenstrydigheid in die BKBT se formulering van kredietportefeulje kapitaalkostes aan te spreek. Die oorsaak van hierdie teenstrydigheid is vasgestel en die effekte daarvan bespreek met verreikende gevolge vir alle kleinhandel leningsportefeuljes. Ten slotte is die gebrek aan ’n robuuste tegniek om kleinhandel batekorrelasies uit empiriese lenings- verlies data te ekstraheer, ondersoek. ’n Metodologie wat die onderliggende BKBT formulering vir kredietrisiko gebruik, is bepaal en die resultate verkry word vergelyk met kleinhandel batekorrelasies soos gestipuleer deur die BKBT. Die empiriese korrelasies (en geassosieerde kapitaalkostes is as aan- sienlik laer as die BKBT korrelasies (en kostes) bevind, selfs tydens die verhoogde verliese wat tans (2009) ondervind word. Die akkuraatheid van hierdie belemmerende beperkings in portefeulje ver band is geassesseer en voorstelle vir verdere empiriese studie word aan die hand gedoen.
English: The credit crisis (which began in August 2008) has affected almost every segment of the international financial system. Credit has been severely curtailed as banks struggle to contain further losses caused by reckless lending practices that characterised the last two decades. Asset prices have tumbled as fearful investors flee to safer havens, abandoning traditional investments and hedge funds with reso- lute consistency. Governments – in an attempt to stave off stagflation and kick-start failing economies – have reduced interest rates to historic lows, initiated stimulus packages and instigated bank bailouts, but the efforts have (as yet) had minimal to no effect on markets. The dire economic environment characterised by diminishing industrial production, falling house (and other asset) prices and rising unemployment, has only discouraged spending and investing and promoted capital hoarding. In the ensuing crisis, the regulatory economic environment (dominated by the Basel Committee for Banking Supervision's (BCBS) Basel II Accord) has proved inadequate. Potential solutions have not yet pre- sented themselves and the crisis looks likely to continue for the foreseeable future. In the light of these events and contemporary failings of finance in general, the need to continuously augment existing and invent new techniques to measure and manage financial risks are paramount. This thesis explores four significant problems facing modern risk management in a portfolio context. The first problem examines the assumption of normally distributed portfolio returns. Compelling evidence for the consistent failure of this assumption is provided. A measure for ranking portfolio per- formance is discussed and explained with reference to several South African hedge fund portfolios. The second of these problems explores the assumption of unlimited liquidity in market risk measurement models. This assumption has been shown to be utterly fallacious and indeed, is now be- lieved to be the principal component of the credit crisis. A new portfolio market risk model, which incorporates the effect of severely diminished liquidity, is introduced and applied to several South African market portfolios. The results indicate a substantially improved model of market risk. The third problem probes the effect of obligor default quality discrimination to address a subtle discrepancy in the BCBS's formulation for credit portfolio capital charges. The cause of this discrepancy is located and its effects discussed with far reaching consequences for retail loan portfolios. Finally, the lack of a robust technique to extract retail asset correlations from empirical loan loss data is investigated. A methodology is devised using the underlying BCBS formulation for credit risk and the results obtained are compared with retail asset correlations stipulated by the BCBS. The empirical correlations (and the associated capital charges) were found to be considerably lower than the BCBS correlations (and capital charges), even during the elevated losses currently (2009) being experienced. The accuracy of these punitive impositions in a portfolio context is assessed and suggestions are made for further empirical study.
English: The credit crisis (which began in August 2008) has affected almost every segment of the international financial system. Credit has been severely curtailed as banks struggle to contain further losses caused by reckless lending practices that characterised the last two decades. Asset prices have tumbled as fearful investors flee to safer havens, abandoning traditional investments and hedge funds with reso- lute consistency. Governments – in an attempt to stave off stagflation and kick-start failing economies – have reduced interest rates to historic lows, initiated stimulus packages and instigated bank bailouts, but the efforts have (as yet) had minimal to no effect on markets. The dire economic environment characterised by diminishing industrial production, falling house (and other asset) prices and rising unemployment, has only discouraged spending and investing and promoted capital hoarding. In the ensuing crisis, the regulatory economic environment (dominated by the Basel Committee for Banking Supervision's (BCBS) Basel II Accord) has proved inadequate. Potential solutions have not yet pre- sented themselves and the crisis looks likely to continue for the foreseeable future. In the light of these events and contemporary failings of finance in general, the need to continuously augment existing and invent new techniques to measure and manage financial risks are paramount. This thesis explores four significant problems facing modern risk management in a portfolio context. The first problem examines the assumption of normally distributed portfolio returns. Compelling evidence for the consistent failure of this assumption is provided. A measure for ranking portfolio per- formance is discussed and explained with reference to several South African hedge fund portfolios. The second of these problems explores the assumption of unlimited liquidity in market risk measurement models. This assumption has been shown to be utterly fallacious and indeed, is now be- lieved to be the principal component of the credit crisis. A new portfolio market risk model, which incorporates the effect of severely diminished liquidity, is introduced and applied to several South African market portfolios. The results indicate a substantially improved model of market risk. The third problem probes the effect of obligor default quality discrimination to address a subtle discrepancy in the BCBS's formulation for credit portfolio capital charges. The cause of this discrepancy is located and its effects discussed with far reaching consequences for retail loan portfolios. Finally, the lack of a robust technique to extract retail asset correlations from empirical loan loss data is investigated. A methodology is devised using the underlying BCBS formulation for credit risk and the results obtained are compared with retail asset correlations stipulated by the BCBS. The empirical correlations (and the associated capital charges) were found to be considerably lower than the BCBS correlations (and capital charges), even during the elevated losses currently (2009) being experienced. The accuracy of these punitive impositions in a portfolio context is assessed and suggestions are made for further empirical study.
Description
Thesis (Ph.D.(School of Management))--University of the Free State, 2009
Keywords
Financial risk management, Risk management, Credit -- Management, Performance measures, Asset correlation, Liquidity value at risk, Portfolio optimisation, Credit risk